Review of the Municipal Tariff Guideline and Benchmarks for the financial year 2008/09

Review of the Municipal Tariff Guideline and Benchmarks for the financial year 2008/09
Avianto - 02 October 2007

Issues for discussion 1. Introduction and Background
2. The Municipal Tariff Guideline 3. The Municipal Tariff Benchmarks 4. The way forward 5. Closure

Introduction and Background
Brian Sechotlho

NERSA on an annual basis calculates an appropriate electricity price increase, which is then sent through to municipal distributors as a guide to them in determining their annual electricity tariffs. This guideline does not preclude a distributor from the legal obligation to apply to the Regulator for tariff increases before implementation. NERSA also reviews the tariff benchmarks that are used in the evaluation of the municipal tariff applications. These benchmarks are used together with the financial benchmarks to assist in determining the financial viability of the distributors and guide tariff limitations. NERSA published the consultation paper on the review of the municipal tariff guideline and benchmarks for the financial year 2008/09 on 11 September 2007; Stakeholders were invited to comment on the paper by 27 September 2007. Comments were received from 8 stakeholders (AMEU, Buffalo City, Ekurhuleni Municipality, Eskom, Ethekwini Municipality, Newcastle Municipality, NiMBLE and Steve Tshwete Municipality) – we thank you;

Municipal Tariff Guideline
Discussion led by Tabisa Nkopo

The guideline has been calculated after taking into consideration the request from Eskom for a review of the rules that were approved and applied within the MYPD process. The Eskom price increase for 2008/09 was approved as 6.2%. The staff further presented five scenarios taking into account the recent application by Eskom for MYPD rule change. The scenarios present a 6.2%, 8.06%, 11%, 14.2% and 18.7% Eskom’s price increases presented in the rule change application. The results of the scenarios for the guideline are as follows: 6%, 7.3%, 9.2%, 11.4% and 14.4% respectively.

Municipal tariff guideline
The issues covered are adequate, and there is a suggestion that expenses related to EEDSM, funded from the municipality should also be considered. NERSA’s proposal of determining the guideline is supported, but other stakeholders are of the opinion that it is inadequate by just mentioning the impact of the Municipal Finance Management Act (MFMA) where the time lag between the implementation of increases to municipal customers buying directly from Eskom will cause a different price increase that will be applied to municipalities. A suggestion has been made that the impact of the time lag before implementation of municipal tariffs due to the MFMA should be treated as a separate issue that needs to be considered in paragraphs 2 &3 of the consultation paper. # 1. Stakeholders are requested to comment on the adequacy of the issues considered in determining the guideline

The assumption that electricity purchases by municipal distributors is 67 % of their total costs to supply end-use customers does not take into account the wide variations in the size of municipal distributors, their load profiles, customer mix and the purchase tariff of each municipality. Using this figure for all distributors will result in tariffs that do not fall within the guidelines; The issues considered in determining the guideline represent unfair comparison when the small distributor is bench-marked with Metros. # 1. (cont) Stakeholders are requested to comment on the adequacy of the issues considered in determining the guideline

# 1. (cont) Stakeholders are requested to comment on the adequacy of the issues considered in determining the guideline EDI Holdings or NERSA has not discussed the tariff rationalization process with municipal distributors. Municipalities are not privy to the tariffs that are applied in all the other distributor areas that may be incorporated into a particular RED. If no plan or principles of tariff rationalisation are available, this issue cannot be used to set benchmarks for municipal tariffs.

# 2. Stakeholders are requested to comment on the use of these economic parameters that were assumed by NERSA in determining the guideline. The economic parameters appear within expected ranges. The statement; “The CPIX is used as an inflation index throughout the determination period” assumes that the other indices are irrelevant. The CPIX figure of 5.6% for the 2008/09 financial year will be understated for many municipal distributors when considering some of their costs such as salaries, equipment and material costs. This is especially so when some of the smaller distributors are unable to take advantage of economies of scale.

# 2. (cont) Stakeholders are requested to comment on the use of these economic parameters that were assumed by NERSA in determining the guideline. The utilization of the CPIX as an economic parameter is not recommended and the PPI should rather be looked at. It must also be realised that whatever indicator is being used, the drastic effect of the proposed tariff increases will have an effect on the period when the tariff will apply and can the level that realised over the previous year not adequately serve as norm for consideration. It is recommended to consult the Reserve Bank when setting economic indicators.

# 2. (cont) Stakeholders are requested to comment on the use of these economic parameters that were assumed by NERSA in determining the guideline. The economic parameters need to be revised. NERSA’s forecasted CPIX for 2007/08 is 6% and 5.6% for the 2008/09 financial year. However, the current CPIX stands at 6.3% (August 2007). One of the primary cost drivers of re-capitalisation and deferred maintenance, in the electricity business, is the exchange rate. The CPIX, together with the anticipated depreciation of the Rand translates into a higher than 6% CPIX for the energy industry. Taking into account the prospect of around a 10c/l petrol price hike in October (and possibly in November as well), CPIX inflation could be as high as 7.1% by the end of the year, averaging 7.0% in the fourth quarter of It is expected that CPIX inflation will peak at 7.3% in February 2008.

The cost components are acceptable and such benchmarks, could be used by other municipalities to benchmark their own situations. The cost structure is reasonable although it is suggested that the item headed ` Other charges’ be split into a number of sub-headings as they could vary significantly among distributors. The suggested sub-items are: General expenses Contribution to Rates and General Services Fund Inter-departmental charges Contribution to Capital Development Funds, provision for bad debt etc The comparison of the cost component percentages of municipalities and Eskom distribution is inconsistent as many of the municipal distributors have significantly different customer bases and cost pressures to that of Eskom. # 3. Stakeholders are requested to comment on the cost structure

# 3. (cont) Stakeholders are requested to comment on the cost structure The proportion of costs as presented in the tables does not compare to the real situation of the small distributor. The portion of Repairs and Maintenance is in practice 6% to 10% and the cost of capital for expansion or upgrading has a larger effect and found to be 15% rather than the 7% as mentioned.

# 4. Stakeholders are requested to comment on the energy purchases The assumption that the cost of energy purchases for all municipalities represents 67% of their total expenditure is imperfect, as it does not take into consideration the wide variation in size of the municipal distributor load profile and customer mix. Purchases from different municipalities vary among different municipalities; If the average of 67% is going to be used for municipalities it could have a major effect on municipalities that purchase less than 67%.

# 5. Stakeholders are requested to comment on salaries and wages The negotiated salary and wages increases for 2008/09 will be 8.75% which is significantly above the quoted CPIX index. For some municipal distributors the percentage of total expenditure on salaries and wages already exceeds the 11% quoted in the paper. Many of these municipalities are also desperately attempting to fill crucial vacant positions which will increase the level of expenditure on this item even further. The assumption then that this expenditure will “increase by inflation” is also not appropriate. It is normally found that annual salary adjustments are not only based on the CPIX level but 1,5% to 2% is regularly added.

# 6.Stakeholders are requested to comments on repairs and maintenance Repairs and maintenance also vary among different municipalities. The control use of maintenance levy (perhaps a more suitable term could be coined) should be encouraged to address backlogs in refurbishment and maintenance. One stakeholder stated that they have budgeted 9% and mentioned that this figure is expected to increase in the next financial year owing to an accelerated maintenance plan over the next few years.

The comment on page 10 of the paper states that “Municipalities will be allowed to move towards an average of 5% (of total expenditure) for maintenance and refurbishment”, some municipalities do not have well coordinated preventative maintenance plans. Clarity is needed on how NERSA arrived at this indicative figure of 5% for this expenditure item for 2006/07. Are the municipalities whose budgeted expenditure is in excess of the 5% to be penalized in their tariff applications if this expenditure contributes to the tariffs falling outside the guidelines? # 6. (cont) Stakeholders are requested to comments on repairs and maintenance

# 6. (cont) Stakeholders are requested to comments on repairs and maintenance The investment by small distributors in repairs and maintenance vary between 6% and 10% and therefore municipalities who do proper maintenance should not be penalized by the proposed model. Repairs and maintenance, itself, is not the primary cost driver. The exchange rate for maintenance parts from foreign countries and CPIX are the primary cost drivers. Increasing the maintenance and refurbishment percentage of individual municipalities, in a controlled fashion, should be allowed to accommodate backlogs.

# 6. (cont) Stakeholders are requested to comments on repairs and maintenance It is suggested that repairs and maintenance should be split between repairs and maintenance and also deferred maintenance.

The cost items are deemed adequate. There is a concern from one stakeholder that in order to recover its approved revenue requirement - that if NERSA approved an Eskom average price increase of 14%, the municipal tariffs will need to go up by 20% due to the later implementation of the increase. The subtleties of this issue are not clarified in sufficient detail in the document and therefore it is possible that the values used create an incorrect impression. # 7. Stakeholders are requested to comment on the cost items used in determining the guideline increase

# 7. (cont) Stakeholders are requested to comment on the cost items used in determining the guideline increase There is a concern about a statement in the document that the expected price difference for municipalities will not be hugely different from the Eskom average price increase. This a concern as there is a view that the expected price difference is significant. There is concern that 5.6% CPIX is an unrealistic assumption for all municipal costs other than electricity purchases.

The document gives the impression that the price increase percentages for the different scenarios for municipalities are close to the final percentages, and that it is expected that the adjusted price will not be hugely different and can even be lower than the general Eskom price increase. This statement is confusing and needs to be clarified and explained in more detail in the document. # 7. (cont) Stakeholders are requested to comment on the cost items used in determining the guideline increase

# 7. (cont) Stakeholders are requested to comment on the cost items used in determining the guideline increase Municipalities are being restrained by the macro economic indicators established by National Treasury which do not provide a true reflection because any Eskom tariff impact above it has a large impact on the total cost of municipalities. In the calculation of all tables computing the expected weighted average increase in total costs of municipal distributors, does this final percentage apply to sales or input costs? NERSA needs to explicitly state this in the discussion paper.

Questions and discussions

Municipal Tariff Benchmarks
Discussion led by Mosima Matabane

Introduction & Background
The proposed guideline increase for 2008/09 from the various scenarios is applied to the existing benchmarks to establish revised benchmarks and a lower benchmark is adjusted with a range of 4c as previously applied to get the upper level. The current benchmarks are reviewed to ensure that there is a smaller gap which will assist in a quicker rationalization of existing tariffs.

Introduction & Background
The existing benchmarks that are being revised are based on five assumed tariff/customer classes. Consumption levels for these customer classes are also assumed. It should be noted that these are average consumption levels and that there may also be other tariff classes at various municipalities which will cater for other customer classes or consumption levels that are very different from the ones that are assumed. Where such anomalies exist, the applications will be treated on a case-by-case basis. The customer classes are as follows: Domestic low tariff Domestic high single phase tariff Commercial (small business) high single phase Commercial Prepaid Industrial / Large user tariff The revised benchmarks for each scenario are given on page 16 – 17 of the consultation paper.

Municipal tariff benchmarks
#8. Stakeholders are requested to comment on whether the use of the assumed customer categories and consumption levels are appropriate. The assumed categories may be used as proposed. The possibility of adding a 60% load factor on a demand of 500 kVA should be considered. If the tariff contains a time-of-use component, the peak percentage consumption should be stated, as well as standard and off-peak consumption percentages. In terms of the value of “100 kWh per month” assigned to the “domestic low tariff”, one municipality’s average level is around 275kWh and 300 kWh. Using the 100 kWh level, given the level of FBE provided, will yield a zero cost account for residential customers. Municipalities use different consumption levels but for consistency the benchmarks may be used.

The benchmarks used by NERSA are not appropriate because of very different classification of customers by different municipalities as mentioned below :- One stakeholder stated that they do not differentiate between Domestic Low and Domestic High. There is no basic charge for High Domestic. Also all Commercial customers are grouped per tariff type rather than small/large user. Further they don’t differentiate between Commercial and Industrial, but rather on tariff suitability per customer category, i.e. Scale 1 – generally commercial /industrial Scale 2 – generally commercial /industrial #8. (cont) Stakeholders are requested to comment on whether the use of the assumed customer categories and consumption levels are appropriate.

Commercial is not defined as 2000kWh and smaller but can include very large Commercial and Industrial customers as well. Commercial Prepaid – very small number and not feasible to have separate benchmark- it is recommended that they fall within residential benchmark. Industrial – generally defined 100kVA and above, with a Demand component - depends on tariff suitability or consumption patterns, i.e. 3 Part Bulk – generally industrial TOU - generally industrial #8. (cont) Stakeholders are requested to comment on whether the use of the assumed customer categories and consumption levels are appropriate.

There is a concern as to how these benchmarks deal with a municipality that does not distinguish between low and high consumption domestic customers? On what basis was a consumption level of 2000 kWh per month arrived at for a `commercial [small business] single phase’ customer or a load factor of 30% for the assumed typical `large/industrial’ customer. #8. (cont) Stakeholders are requested to comment on whether the use of the assumed customer categories and consumption levels are appropriate.

The various benchmarks taken into consideration are not appropriate to all the categories of consumers being supplied by the small distributor. It is suggested that the benchmarks be sub-divided into low, medium and high consumption users. Only 5 customer categories are catered for and it appears as if this is based on Eskom customer classes. This needs to be expanded to cater for time-of-use, high-voltage and low-voltage customers. #8. (cont) Stakeholders are requested to comment on whether the use of the assumed customer categories and consumption levels are appropriate.

# 9. Stakeholders are requested to comment on whether the approach of using these benchmarks as a basis in determining the proposed benchmarks is appropriate. The RED 2 “domestic low” category appears to be low, if FBE is excluded from calculations. The adjusted seasonal rate for some municipalities is in the region of 47,5 falling outside of the parameters set. The “domestic high” rate is acceptable, although the parameter set for RED 1 will be better suited to this category. “Commercial” and “commercial prepaid” is acceptable, although it will be better if there is no difference in electricity prices between the commercial and residential groups. The “industrial” levels are acceptable.

# 9. (cont) Stakeholders are requested to comment on whether the approach of using these benchmarks as a basis in determining the proposed benchmarks is appropriate. The statement in the document that the current benchmark levels were determined based on the 2005/06 approved average tariff levels, with a 4c range from lower to upper level is noted with concern. This statement raises the following questions: Why has no escalation been applied to the 2005/06 figures to arrive at the stated benchmark figures for the 2006/07 and 2007/08 tariff applications. When were the original benchmark figures calculated and what was the basis for this determination. How have these benchmark figures been escalated year-on-year since their introduction.

# 9. (cont) Stakeholders are requested to comment on whether the approach of using these benchmarks as a basis in determining the proposed benchmarks is appropriate. Municipalities do not use the same definitions of customer category, therefore, the approach is not appropriate. The benchmarking make it difficult for the small municipalities to comply It is requested that NERSA disclose the methodology of calculating these benchmarks, for the municipalities to comment and help with more accurate information.

#10. Stakeholders are requested to comment on whether the approach used in determining the new benchmarks is appropriate. There is a concern that benchmarks are not related to the real costs to supply customers. The impact is that tariffs are rationalised at a specific price level for a specific customer category, but there is a risk in recovering the correct revenue (either over or under) if it is not compared with the cost of supplying the electricity. It, however, is probably the best approach in the current circumstances.

#10. (cont) Stakeholders are requested to comment on whether the approach used in determining the new benchmarks is appropriate. The statement in the document that mentions the urgency to review the benchmarks is noted with concern. It raises the following questions: Previous benchmarks are escalated by the `proposed guideline increase’ to produce new benchmarks.

How has the different nature and cost structures of the various municipalities been incorporated into the benchmark figures and/or the review process where anomalies are found to exist. Why has the increase in municipal costs (excluding electricity purchases) been deemed to be equivalent to a CPIX figure when evidence clearly indicates that this is an unrealistic figure to use. On what basis has the lower benchmark been adjusted with a range of 4c as previously applied to get the upper level. #10. (cont) Stakeholders are requested to comment on whether the approach used in determining the new benchmarks is appropriate.

#10. (cont) Stakeholders are requested to comment on whether the approach used in determining the new benchmarks is appropriate. The impact on the smaller distributor is of such kind that there cannot adequately be competed with the larger metro with regard to operating costs and the cost for capital.

The benchmarks appear to be in order. The more lenient approach on surplus is appreciated, given that strong efforts to improve efficiency, should be rewarded. Insufficient information on the reason for the level of the financial benchmarks has been provided in the paper to make informed comment on whether or not they are appropriate. These benchmarks would certainly need to be reviewed based on the following observations: It is not clear how a `surplus’ percentage can be seen as a measure of the `efficiency of an organisation’. What informs the decision that a surplus of 15 – 20 % is `efficiently achieved’ and on what basis is this efficiency judged. # 11. Stakeholders are requested to comment on whether the already existing financial benchmarks need to be revised or not. Stakeholders are also invited to comment on whether the financial analysis against the benchmarks is appropriate for determining the efficiency of the municipality.

# 11. (cont) Stakeholders are requested to comment on whether the already existing financial benchmarks need to be revised or not. Stakeholders are also invited to comment on whether the financial analysis against the benchmarks is appropriate for determining the efficiency of the municipality. Do the System losses of 10% include technical and non-technical losses. If they include non-technical losses, why would these be acceptable if technical losses are significantly less than 5%. Does this benchmark take the size of the municipal distributor into account. On what basis has the Average Sales Price/Average Purchase Price (ASP / APP) ratio of 1.75 been selected. How have NERSA staff been able to determine the cross-subsidisation ratios inherent in municipal tariffs when most municipalities have not carried out `cost of supply’ studies and no cross subsidy framework has been finalised by NERSA.

# 11. (cont) Stakeholders are requested to comment on whether the already existing financial benchmarks need to be revised or not. Stakeholders are also invited to comment on whether the financial analysis against the benchmarks is appropriate for determining the efficiency of the municipality. How are these cross subsidisation ratios used in the assessment of tariff applications when approvals appear to generally be approved or rejected if they fall within the benchmark levels or not. It is suggested that the methods and calculations for these financial benchmarks be disclosed to municipalities for revision. The current assumptions are out of date and it is recommended that each major municipality submit their current financial benchmarks.

Additional comments There is a general concern on how the adjustment to the approved Eskom tariff increase for 2008/09 [effective 1 April 2008] to allow for the MFMA requirements [increase effective 1 July 2008] will be calculated, and; What will be the effect of Eskom’s Retail Tariff Restructuring Plan, which covers the proposed changes to Eskom’s retail tariff to be implemented in 2008/9, on the electricity purchase costs of municipalities.

Questions and discussions

Process & Way Forward Discussion led by Mbulelo Ncetezo

Process & Way Forward From this workshop, NERSA staff will revise the guideline and benchmarks accordingly and recommend to the Electricity Subcommittee. Public hearings scheduled for 22nd November 2007. The closing date is 18 November 2007 Comments to: Further consultations at Polokwane, Bloemfontein, Durban and Cape Town from 16 – 21 November in that sequence. Final approval by the Regulator is expected to take place on 20 December 2007.

General discussions

Review of the Municipal Tariff Guideline and Benchmarks for the financial year 2008/09

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Review of the Municipal Tariff Guideline and Benchmarks for the financial year 2008/09

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